Why a Dip in Asset Prices Might Be a Good Thing

There's a lot of wealth being created and not enough safe places to store it.

What goes up, sometimes comes down.

Photographer: Michael Nagle/Bloomberg

Is there an argument that high asset prices are bad news, and that their declines can be OK? We’re familiar with the contention that dangerous bubbles should be popped, but is there another way of justifying this contrarian intuition? I’d like to lay one out, keeping in mind that this is speculation and not an endorsement.

Let’s start with an observation: In a volatile and uncertain time politically, we have observed sky-high prices for blue-chip U.S. equities. Other asset prices also seem to be remarkably high: home values and rentals in many of the world’s top-tier cities, negative real rates and sometimes negative nominal rates on the safest government securities, and the formerly skyrocketing and still quite high price of Bitcoin and other crypto-assets.

Might all of those somewhat unusual asset prices be part of a common pattern? Consider that over the past few decades there has been a remarkable increase of wealth in the world, most of all in the emerging economies. Say you hold enough wealth to invest: What are your options? Well, the stock markets of China and Russia are unsafe and not well developed, and many other emerging economies, such as Turkey and Brazil, have been wracked with uncertainty and political turmoil. So you might take a disproportionate share of your money and put it into high-quality, highly liquid assets. That might include the stocks of the Dow Jones Industrial Average and real estate in London, to name two possibilities.

In relative terms, the high-quality, highly liquid blue-chip assets will become expensive. So we end up with especially high price-to-earnings ratios and consistently negative real yields on safe government securities. Those price patterns don’t have to be bubbles. If this state of affairs persists, with a shortage of safe investment opportunities, those prices can stay high for a long time. They may go up further yet.

These high asset prices do reflect a reality of wealth creation. They are broadly bullish at the global scale, but they don’t have to demonstrate much if any good news about those assets per se. Rather there is an imbalance between world wealth and safe ways of transferring that wealth into the future.

How do Bitcoin and other crypto-assets fit into this picture? Well, they are not safe in the sense of having stable prices. There is some chance they will be harbors in bad times, in a manner akin to gold, and they are immune to some forms of political confiscation. So some of the newly created wealth has pushed up the prices of crypto-assets. That again might be a mixed bullish-bearish sign: Wealth creation has outraced our institutional ability to reliably transfer that wealth into the future.

How does the election of President Donald Trump, or perhaps the onset of Brexit, fit into this picture? If you are a Trump skeptic, you might think his actions increase volatility and diminish the long-term future of the U.S. Still, he hasn’t destroyed wealth in the short run and his tax reform may have boosted it, at least for individuals who invest in liquid securities and before the larger budget deficit needs to be paid off. Share prices can go up, whether your view of Trump is positive, negative or mixed.

Note that the volatility of market prices has been at very low levels, both before and after the election of Trump. That may be reflecting two factors: First, the big risks are systemic and thus the price of one stock versus another should not be very volatile. Second, if global wealth holders have nowhere else to go, perhaps the broad indexes won’t be very volatile either. Again, I am working out a train of thought here, rather than suggesting we know this to be true.

What about last week, when prices for many stocks, bonds and Bitcoin fell, even in conjunction with good news about wages and expected economic growth? That too is consistent with this story. As positive reports percolate and spread throughout the American economy, and perhaps in much of Europe too, blue-chip assets become less important as relatively safe stores of value and so their prices might fall.

To sum this all up in a single nerdy finance sentence, in a world where wealth creation has outraced the evolution of good institutions, the risk premium may be more important than you think. Future events will test this hypothesis, but at the very least I am keeping it in the back of my mind. If U.S. equity prices take another big hit, I won’t confuse that with economic calamity, not yet at least.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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